Transcript No Slide Title

MANAGERIAL ECONOMICS
An Analysis of Business Issues
Howard Davies
and Pun-Lee Lam
Published by FT Prentice Hall
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Chapter 7:
Demand and Elasticity
Objectives:
After studying the chapter, you should
understand:
1. The determinants of demand and its elasticity
2. The relationship between revenue and elasticity
3. The link between elasticity and the power of
buyers
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The Determinants of Demand


Demand is the quantity of a product that purchasers
are willing and able to purchase in a specified period
It is determined by
– Own Price - Po
– Price of other products, especially close substitutes and
complements, Pc,s
– Consumers’ disposable incomes, Yd
– Consumers’ tastes, T
– The amount spent on advertising the product, Ao
– The amount spent on advertising complements and
substitutes, A c,s
– Interest rates (i) and credit availability (C)
– Expectations of future prices and supply conditions(E)
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These Relationships May be
Represented As:

A ‘demand function’ - the general
mathematical form
• Qd = f(Po,Po,Ps,Yd,Ao,Ac,As,I,C,E)

A ‘demand curve’
Price
The demand curve shows the quantity that would
be bought at each price, for some fixed
combination of all other factors
Quantity Demanded
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The Demand Curve

D-curve shifts when anything except ownprice changes
Own Price
A demand-curve shows the quantities sold at each
price, assuming other things do not change.
“Assume” here does not mean “we believe this to be
true” but simply “if”. We know the other things
change but we can only show two dimensions on a
diagram.
Quantity Demanded
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Concepts of Elasticity

Own price elasticity is:
– percentage change in quantity demanded, divided by percentage
change in price:

If demand is price-elastic, revenue

increases with lower prices.
If demand is price-inelastic, revenue decreases with lower prices
Cross-price elasticity of demand between substitutes is positive

Income-elasticity determines how demand changes with customers’ incomes.

For most goods income-elasticity is

positive.
Advertising elasticity is important in deciding on advertising budgets. It is
positive. As the level of advertising increases, we would expect advertising
elasticity to fall.
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The Demand-Curve:Examples

Zero-elasticity at all prices
Price
Ed = 0
Quantity
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The Demand-Curve:Examples

Infinite elasticity at all prices
Price
Ed = 
Quantity
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The Demand-Curve:Examples

Unitary elasticity at all prices
Price
Ed = -1
This curve is a ‘rectangular
hyperbola’ such that price x quantity
is a constant
Quantity
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The Demand-Curve:Examples

A Linear Demand Curve
Price
Ed = -
Ed = -1
Ed = 0
Quantity
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Demand and Marginal Revenue

$
A Linear Demand Curve
Ed = -
Ed = -1
Ed = 0
Quantity
Marginal Revenue
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Determinants of Own-price
Elasticity

Substitutes: how close and at what prices?
– How narrowly defined is the product? The more
narrowly defined the more close substitutes


Proportion of consumers’ income spent on
the product (or % of industrial buyers’ costs
accounted for)
Time. Demand is more elastic over longer
periods of time
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Determinants of Other
Elasticities

Income Elasticity
– Type of good
• necessities - salt, drinking water, zero elasticity
• luxuries, zero at low levels of income then high when
income thresholds exceeded
• inferior goods - negative, purchase less as income rises bus travel, low-grade margarine, paraffin

Cross-price elasticity
– substitutes or complements,and how close?
– An industry is a group of firms producing products
with high positive cross-elasticities
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The Demand Curve for an
Individual Firm




Depends on the conditions of competition
For a monopoly, industry demand curve is the
firm’s demand-curve
Under perfect competition, demand is
infinitely elastic at the market price
Where competition is amongst a few firms it
depends on each firm’s market share and
rivals’ reactions
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Elasticity and the Power of
Buyers


Chapter 11 introduces the concept of ‘buyer
power’ which is one of the ‘5-forces’
determining the structure of competition in an
industry
Buyer power has two components
– price sensitivity of buyers (looser version of
the elasticity concept)
– bargaining power of buyers
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Price Sensitivity of Buyers Is
Determined By:






Purchases of product as % of total purchases
Product differences and brand identity
Impact of product on the quality of the buyers’
product or service
Customers’ own profitability
Decision-makers’ incentives
THIS USEFULLY EXTENDS THE ANALYSIS OF
DEMAND AWAY FROM CONSUMERS TO
INDUSTRIAL BUYERS AND PROVIDES A LINK TO
MARKETING
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